Four Hidden Risks of Margin Debt

I'm more worried about the hidden risks and pitfalls that the average margin investor might not have considered. These pitfalls can make margin trading more risky than meets the eye -- and more risky than other forms of debt we're more familiar with.

• Your downside risk isn't limited to the collateral in your account. We're all used to the real estate model, in which, in the event of a calamity, the most you can lose is your home and any equity value you have in it. That's not so with margin. You can be called for funds beyond the equity position in your account, and those funds must come from elsewhere.
• Your security positions can be sold, without your consent, to meet a margin call. Now, imagine your mortgage company selling your house -- without telling you -- to meet a collateral obligation! No way. Brokerages can do pretty much what they want, when they want, without consulting you, to meet minimum maintenance requirements. And it probably won't be what you want.
• You aren't entitled to an extension. You can work with almost any other creditor to negotiate a late payment to keep the loan in force. Not so with margin loans.
• Minimum maintenance requirements can be changed at any time without written notice. This one's the worst of all, and for that matter, interest-rate changes don't have to be disclosed, either. So the deal you think you have with your broker can change at any time.

  Fortunately, recent history suggests brokers rarely change the minimum maintenance requirement and have only made minor tweaks to the interest rates. But in a panic, who knows? And that's just when you would want stability.

  Also, don't forget they can change the maintenance requirements for individual securities. So if you hold 500 shares of Autobytel (ABTL) in an E*Trade account, the minimum maintenance requirement is 50%, not 30%. Such a change might trigger a forced sale. And they can go all the way to 100% maintenance requirements, again without notifying you.

  I'm a big proponent of disclosure, and this lack of disclosure is scary.

I'm not saying you should avoid margin altogether; it has its place for those who know what they're doing. But that also means knowing the traps and pitfalls, along with the ropes.

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